White Marsh Bankruptcy Attorney: Tax Refunds in Chapter 13

In a Chapter 13, the disposable income of a debtor has to be used pay unsecured creditors pursuant to the Bankruptcy Code, 11 U.S.C. §1325(b)(1)(B): “If the trustee or the holder of an allowed unsecured claim objects to the confirmation of the plan, then the court may not approve the plan unless, as of the effective date of the plan– (B) the plan provides that all of the debtor’s projected disposable income to be received in the applicable commitment period beginning on the date that the first payment is due under the plan will be applied to make payments to unsecured creditors under the plan.”

Most  Chapter 13 Trustees’ including those in Maryland, subscribe to the notion that income tax refunds received by debtor (refunds obtained due to the withholding of income of the debtor) are part of the disposable income. The courts around the country have agreed with the trustees.  “Most courts have determined that tax refunds should be included in the §1325(b)(1) “projected disposable income” calculation. In re: Kruse, 406 B.R. 833, 837 (Bankr. N.D. Iowa 2009); In re Cleaver, 426 B.R. 390, 394-395 (Bankr. D. N.M. 2010). Hence, whenvenever the plan does not pay 100% of unsecured creditors, the Chapter 13 Trustee will require that the debtor turn over income tax refunds.

Some courts have created an opening for debtors if they can establish that the money will be used for reasonable and necessary expenses. The test is as follows:“(1) whether the expenses are necessary and the amounts reasonable; (2) whether the expenses fall within the expense categories in Schedule J; (3) whether the particular expense was foreseeable within the category; and (4) whether there is sufficient money within the category to pay the expense” In re: Kruse, 406 B.R. 833, 837 (Bankr. N.D. Iowa 2009) quoting, In re: Wistey, No. 08- 00555M, 2008 Bankr. LEXIS 2051, slip op. at 2at *3-4 (Bankr. N.D. Iowa June 25, 2008).

The debtor’s right to a federal income tax refund arises at the end of the tax year and not when filing occurs. This definition means that debtor cannot simply wait until after the plan period is over to file to avoid turning over the refunds to the trustee.  2002).

For married debtors whose spouses are not part of the filing, it is important to calculate the tax refund each party is entitled to receive to ensure that the non-filing spouse gets his or her refund and not the trustee.  Debtor should prepare hypothetical “married filing separately” (MFS) returns to determine the amount of refunds and use this to apportion the joint refund.